As financial institutions press the pedal on digital adoption to enhance customer experience and widen their reach, embedded finance has emerged as an innovative approach to connect with a vast pool of consumers who may have a digital footprint but no direct interaction with the financial institution.

Over the past decade, adoption of embedded finance has surged, and digital platforms have expanded into markets that were once the stranglehold of conventional financial institutions,

The shift has prompted a surge in collaborative ventures with non-financial entities, facilitated by open business models and partnership ecosystems. Indications are the trend is here to stay.

In the milieu, the payment vertical within embedded finance has undergone a substantial transformation, boasting a compound annual growth rate (CAGR) of 76 per cent and 28 per cent in transaction volume and value, respectively, between fiscals 2021 and 2023.

Unified Payments Interface (UPI) transactions have led the way, logging a CAGR of 94 per cent in volume and 84 per cent in value. Most key indicators favour the shift. For one, the number of internet data subscribers has surged 44 per cent to 883 million in 2023 from 615 million in 2019.

Mobile phone penetration is increasing, with sales expanding by 36 per cent from ₹1.94 trillion to ₹2.64 trillion in the past four years.

Increased purchasing power of borrowers, supported by economic growth, easy availability of funds and continued innovation in selling blended products such as ‘buy now, pay later’ or BNPL, zero-interest financing and cash-back offers, will be a catalyst too.

Significant growth in penetration e-commerce across geographies, along with increasing digital literacy, is supporting financial institutions in targeting new segments by cross-selling — to travel service providers, for instance.

Growing tech stack has increased the digital footprint of borrowers, enabling better credit evaluation and helping extend financing to borrowers considered ineligible earlier.

Further, increasing partnerships within financial institutions and with non-financial institutions with the aim of creating a niche can also be leveraged to push financial products to large groups of individuals.

Then, there are the inherent virtues — for instance, embedded finance leads to creation of unique selling propositions such as providing curated customer-centric services and on-tap availability of funds (availability of financing at point of purchase), thereby removing intermediaries and supporting better funding cost.

That said, challenges do abound. Among others, data privacy and security are primary concerns, given the need to exchange sensitive data among stakeholders.

Transparency, ethical business practices, and customer grievance redressal mechanisms are needed to prevent loss of consumer trust, fraudulent product offerings, data breaches, and money laundering.

Promotion of digital and financial literacy also needs to continue. Ensuring fair competition and preventing monopolistic practices is necessary as increasing competition saturates the market, with multiple players offering similar financial products.

Besides, with the globalisation of digital financial services, it is vital to enact regulations that promote collaboration across borders. So, the imperatives are not far to seek.

It is essential to leverage data analytics using proprietary data and consumer habits gathered by this ecosystem in order to expand the borrower base.

Conventional financial institutions have been hesitant to recognise that customers prioritise products and services that fulfil their specific needs, rather than the financial products designed to facilitate their procurement.

However, transitioning from a product-centric strategy to a client-centric approach focused on meeting individual needs will enable cross-industry offerings while reducing operational expenses.

Through revenue-based financing, e-commerce platforms can assist sellers with limited credit histories in meeting their working capital requirements.

Overall, financial institutions can set themselves apart by specialising in loans for specific industries or market segments through collaborations with non-financial entities that hold a dominant position in the targeted lending space.